by Burt White, Chief Investment Strategist, LPL Financial
· We recommend that investors generally maintain balance across value and growth stocks.
· Improving economic and profit growth create a favorable backdrop for value.
· Our sector views point to balanced style views, particularly our positive views of both technology and financials.
Other factors to consider include relative valuations (favors growth) and technical analysis (favors value).
IS there still Value in value?
Despite a strong 2016, there may still be some value in value. While value has lagged growth so far in 2017, based on the Russell style indices [Figure 1], we see several reasons to like value stocks, including accelerating economic and profit growth, and an improving outlook for the financial sector. But the growth side has enough going for it that we recommend investors maintain balance across the styles. Here we discuss our latest style views.
Slow growth no more?
Economic and profit growth are both poised to improve in the coming months in our view, creating a more favorable backdrop for value stocks that have historically outperformed when growth is accelerating. Economic growth has been subpar during the entire economic expansion (approximately 2% growth on average in gross domestic product [GDP]), which is one of the reasons why growth stocks have outperformed value during the current economic expansion.
The logic here is that when economic and profit growth is scarce, you want to own stocks that can generate their own growth without the need for a macro tailwind. Value stocks tend to need help from the economy to grow. When all companies get a macro lift, and growth is plentiful, the market tends to prefer cheaper stocks to those that are more expensive.
The following analysis (annual data back to 1990) supports this logic:
When economic growth is slow (real GDP below 2.2% annually), growth outperforms value 60% of the time by an average of 3.1%. GDP came in below that pace in the fourth quarter of 2016, but we expect at least 2.5% in 2017. FAVORS VALUE
When the Institute for Supply Management’s (ISM) Manufacturing Purchasing Managers’ Index (PMI) is below average (less than 52), growth outperforms value 60% of the time by an average of 2.5%. The ISM, after accelerating four straight months, came in at 54.5 for December 2016. FAVORS VALUE
When S&P 500 profits grow at below-average rates (less than 7%), growth outpaces value 58% of the time by an average of 5.1%. S&P 500 year-over-year earnings growth is tracking right on that 7% number for the fourth quarter of 2016 (based on Thomson Reuters data). But it is early in earnings season, suggesting more upside may come, and consensus expectations are calling for double-digit earnings gains in 2017. Based on potential upside from policy (tax reform, infrastructure, deregulation, etc.), we believe earnings stand a good chance of eclipsing that 7% mark in 2017, particularly in the second half of the year. FAVORS VALUE
Accelerating growth is certainly not the whole story. We had accelerating economic and profit growth in the late 1990s, and the growth style outperformed. There are other factors to consider, such as sector positioning and valuations as we discuss below. We must also keep time frame in mind and consider that this dynamic may not last very long. The bump up in economic growth that most expect may not come through or may be short-lived, suggesting stints of growth and value outperformance are possible in the year ahead.
Sector outlooks are another important consideration in the growth-value decision. Performance of the biggest value sector, financials, relative to the biggest growth sector, technology [Figure 2], is a key determinant of style performance, as discussed below, but other sectors also play a role: